US Economy
Trend of falling business investment in developed countries
By Michael Hennigan, Finfacts founder and editor
Jun 27, 2014 - 7:02 AM

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The trend of declining business investment in developed economies that has been evident during the financial crisis has been observed since the early 1990s.

Rising cash balances can be attributed to a number of factors: for US firms, the desire to avoid the high headline corporate tax rate by technically parking cash overseas is one incentive, but the trend on investment has been seen also in other countries - - the declines in the European countries are not cyclical, even though 2012 was a recession year in Europe. Germany, for example, experienced a fall in the investment to profits ratio of 0.17 by 2008 - - slightly less than the 0.16 decline shown above.

Dr. Daniel Bachman of Deloitte says that investment spending during the current US recovery has been lower relative to profits than in the past. In the previous recovery, investment averaged 2.2 times profits. In the current recovery, that ratio has fallen to 1.8. The ratio jumps during recessions because profits are more volatile than investment spending.

The decline is part of a trend going back to 1990. Since the end of the 1990 recession, each recovery has been associated with a lower ratio of investment to profits. But that’s after recoveries in the 1970s and 1980s saw the ratio of investment to profits rise.

Dr. Bachman says different US industries experienced surprisingly different changes in the relationship between investment and profits. Information spent over 10 times industry profits on physical and intellectual capital in 1998, a ratio that fell to just 2.8 by 2012. Information also had an annual average rate of growth of profits of 16%, not much less than top-performing mining and finance.

He says goods-producing industries and wholesale and retail trade saw relatively small declines in investments relative to profits and relatively slow profits growth. Services industries such as health care, education, and finance saw the largest declines in investment and the fastest profits growth. The high correlation (80%) between profit growth and lack of investment by industry is an important feature of the weak investment spending that should be considered more carefully. The combination of that relationship and the prominence of industries such as information and finance in contributing to the decline in investment relative to profits suggest that the increasing role of information processing equipment may be an important driver of this phenomenon.

Dr. Bachman concludes: "The most likely explanation seems to be the changing nature of technology. The decline in the United States is concentrated in industries - - such as information and finance - - that use information technology intensively, and it has been a feature of the economy since 1990. That suggests (although it certainly does not prove) that the increasing importance and declining cost of information processing equipment may be a key to understanding the decline in investment spending relative to profits."

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